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By David Stevenson –
A few weeks back you may have noticed that London-based ETF Securities launched the first salvos in what I think will be an absolutely fascinating decade-long war – the inexorable rise of the White Label ETF Platform.
ETF Securities’ platform, known as Canvas, looks to answer a classic conundrum – how does a traditional asset manager (be it in the hedge fund space or traditional mutual funds) look to jump into an exciting new product area such as ETFs without years of experience in that segment? [See ETF Securities launches white-label ETF service].
On paper, ETFs are straightforward beasts and relatively easy to understand, but in reality there are lots and lots of different moving parts behind the scenes, including structuring, legals, and, of course, marketing and distribution. Each bit of this series of moving parts requires expertise, money and, most importantly, management time. Most asset managers simply don’t have enough of any of these! So, why not partner with a specialist, who knows the lie of the land and can get something to market in a relatively short amount of time?
Of course, this new Canvas product isn’t alone in this nascent market place. In the US there is already a growing number of third-party platforms (such as Exchange Traded Concepts, AdvisorShares and ALPS, to name but a few) but I suspect ETF Securities’ real target is also based in London and goes by the name of Source.
Backed by a slew of bulge-bracket investment banks, Source has quietly overwhelmed the market in recent years with a range of products that are built on third-party relationships with the likes of Pimco, Man GLG, Nomura and JP Morgan (the latter two being among the firm’s backers). To be fair to Source, its business model is subtly different from Canvas in that it partners with an existing manager rather than white labels their products, but in effect what we have is an enormous motor for innovation. And it’s that innovation that I think is worth watching as the ETF space develops and mutates. In particular, Source’s recent bevy of ETF launches shines a light on two big trends within the ETF space, namely the relative attractiveness of actively managed ETFs plus the rise of more complex, rules-driven ETFs.
Turning first to those more actively managed structures, Source has pioneered what it likes to call “beta plus” funds which mostly involves working with existing hedge funds and asset managers to bring out products that cost effectively allow investors access to first-rate managers. Source’s partnership with the likes of Pimco and Man GLG is really quite compelling and gives wealth managers in particular the ability to quickly plug into proven investment strategies by managers who matter. I’m not sure that I can add anything to the debate that hasn’t already been said about the Pimco relationship except to say that, in my personal view, if you are looking for fixed income ETFs the choice now is frankly between iShares’ large and extensive range of traditional ‘beta’ products (although both Lyxor and Deutsche Asset & Wealth Management have good products that rival the iShares range) and the Source Pimco products. I would add that in the short-maturity bond space, SSgA SPDR’s line-up is well worth a look.
Source’s latest addition is a GBP-traded version of the Pimco EM Advantage Local Bond Index Source ETF (EMLP) [See Pimco, Source add GBP trading line to EM local bond ETF] which I have to say looks much more attractive than its equivalent iShares product. In passing, I’d also make a small side note about the attractiveness of this asset class generally – a recent HSBC study by their asset allocation guru Fredrik Nerbrand looked at the asset classes most likely to benefit from any sudden 100 basis point spike in 10-year US Treasuries. HSBC observed that emerging market bonds had traditionally performed best, indicating that this relatively niche product area might be one of the best ways for fixed income investors to weather any coming bonds wipeout! If that is the case, the Source Pimco ETF looks a good bet, especially considering its relatively low management fee of 0.60% pa and yield to maturity of over 6% pa.
I’m also intrigued by Source’s Man GLG relationship, which recently spawned an additional two new ETFs – one a play on Continental Europe and the other on Asia. The core of the Man GLG approach is a familiar one: “They use high quality ideas from the leading brokers to create liquid, highly diversified equity portfolios. The strategies aim to further improve the returns from the idea contributors by using a variety of algorithms that detect patterns in the ideas received.”
In confident, bullish markets this approach (alongside Marshall Wace‘s use of earnings surprise data) has been shown to produce better-than-average returns (most of the time) and it’s certainly true that if you believe in the potential for the Eurozone to outperform for instance, then the Source Man GLG Continental Europe Plus UCITS ETF (MPCE) product is interesting [see Source, Man Group collaborate on new active strategy ETFs]. The structuring of the strategy within an ETF, with transparent costs is also a big plus, but with openness and ease of use also comes a threat – we can easily compare “beta plus” ETFs with their real rivals, namely investment trusts!
Source may want to call these new ETFs “beta plus” but they look and smell like active ETFs to me, in that we have an active manager making decisions, albeit quantitatively informed investment decisions. So perhaps we should compare like with like and at this point I sense the debate gets a tad more complicated, with investment trusts beginning a fight back on both costs and performance.
For many years I’ve been berating my friends in the investment trust world to wake up and understand the threat coming from ETFs and it looks like a few of the bigger houses have started to take note. In particular, Schroders, for instance, has started to fight back with lower cost, actively managed traditional unit trust structures. We’ve also seen independent investment trust directors kick up a stink with what they perceive to be underperforming managers, replacing them with new managers. Schroders has also been active in this space with its recent takeover of the Asian Total Returns Trust (from Henderson) perhaps the most interesting transformation. Out went a well-respected growth-orientated investor and in came Schroders’ focused, concentrated stock-picking approach which also made use of a top-down macro overlay to minimise risk…with a track record to kill for. Which brings us nicely to the Source Man GLG Asia Plus UCITS ETF (MPAS). Personally, given the 0.95% management fee plus the 0.45% swap fee, I’d opt for the Schroder’s investment trust every time. I’d say the same also goes for the newly launched Continental European fund which though much more cost effective in terms of TER doesn’t have quite the same track record as say Jupiter‘s European investment trust, with an annual management charge of 0.75% pa.
The other big trend could loosely be called “smart beta” or perhaps more accurately next-generation, quantitative-driven indices that give investors access to investment strategies usually only made available to hedge funds and investment banks. In this category Source’s brand new Source Nomura Modelled PERI UCITS ETF (PERI) is noteworthy. According to Source, the index underlying this index “aims to generate returns similar to the global private equity buyout fund universe, using liquid, public-market instruments: large-cap US equity sectors, mid-cap US equity sectors and cash in major currencies… PERI targets returns similar to the global buyout fund universe, on a committed capital basis, using a combination of equity sector indices and cash in major currencies. To determine its weekly sector and currency exposures, PERI uses a proprietary model developed by Quantitative Equity Strategies LLC, a specialist in liquid alternative investments, which utilises fund data and deal intelligence from leading private equity provider Preqin Ltd” [See Source, Nomura offer private equity exposure in liquid ETF format].
This new ETF is very much aimed at sophisticated investors who are willing to accept that they are investing in synthetic private equity equivalent, not in actual underlying private equity partnerships – many of which are hard to access. In this respect this new private equity tracker is to be applauded as it doesn’t fall into the trap of many of its peers, by only investing in publicly quoted private equity houses and listed fund vehicles available on the main exchanges. But I’m not quite sure that this index doesn’t also fall into another trap which I could loosely call the “black box dilemma” – what exactly is going on inside this index, and how can its investment themes be explained in easy language to the end investor? Perhaps echoing an earlier point, looking at this ETF’s focus on mid-sized private equity (a smart move in my opinion), I’m not sure I wouldn’t rather opt for a …you guessed it, investment trust, in this case in the shape of the superb Hg Capital Trust which has a long track record in this exact same space.
The more general point is that as quant-driven smart beta rises, there’s a real need for absolute clarity about what goes on inside the index. Over in the mainstream of smart beta, optimising indices to minimise volatility and correlations, for example, sounds laudable in constructing lower risk main market indices. But what exactly is going on and what kind of stocks does the end investor actually have a bias towards? Frequently, there aren’t easy-to-understand answers to these questions because it is necessarily complex, but I wonder where the line is where we say this simply isn’t suitable for anyone but the most sophisticated institutional investor with a room full of quants?
(The views and opinions expressed herein are the views and opinions of the author, David Stevenson, and do not necessarily reflect those of ETF Strategy.)